The external cost of internal optimization

Traditional cost reductions don’t take customers in account

Most organisations do not realize they are imposing significant burdens on their users. Any interaction involves a transaction cost. Organizations competed on cost reduction platforms, trying to drive down the transaction cost as low as possible … for their own operations. Quite often, an important part of the transaction cost is pushed onto the user, especially in situations of market dominance. What organizations often fail to see is that users will integrate the cost of the interaction in their choice. Organizations should therefore strive not to lower only their transaction costs, but to reduce the overall transaction burden, including the burden to their users.

The boundaries of cost reduction

Since the late ’80s we’ve gone from reengineering over right sizing to reengineering revisited. The aim, often rightly so, was to cut the fat out of organizations. This ‘fat’ does not add to the value delivery nor to the internal optimization of activities, and has to be removed. As with any exercise, in some cases we cut too deep. On occasion, this turned into an opportunity for certain companies which provided outsourcing services, hence the sudden bloom of the outsourcing business. After all, whether you cut costs or not, the job had to be done.

The focus on ‘core’ activities

Questions on which activities were ‘core’ to the business were asked more and more often, and non-core activities were pushed away, in order for organizations to focus on their core business. Again, not necessarily bad. However … When reengineering and restructuring, organizations often pushed out part of the requirements they had and put these responsibilities with users. It started out as a fadish project. I remember walking around in Southern California in the late 80’s, being charmed by the ‘build your own teddybear’ shops that sprouted like mushrooms. Teddybear fans built their own, and part of the production process was pushed out to the fans. This can go wrong, and we often find it has. We’ve seen situations where users were asked to provide information which the organization had in its systems, again and again.

User revolts

What a lot of companies do not understand is that users will walk away from a difficult interactions. On the contrary, the easier the transaction, the more often users will stick with the organization.

Examples

Let’s look at a couple of internet enabled examples: * Look at purchasing habits of people owning Amazon Kindles. Their purchasing effort is minimal. The ‘one-click’ system allows for a purchase of a book with only one click. Amazon even offers advice based on their extensive purchasing profiles. People who purchased this book, also purchased … * look at the recent introduction of the Genius function to the Apple App Store. Previously reserved only for music selection advice, Apple has extended its functionality to advice clients on relevant apps for their iPhone, iPod Touches or iPads.

Make it easier for users to engage with you than with any other organization

Organizations should strive to make the use decision and especially the administration related to the use decision and actual act of using their tools, services, products … as easy as possible. The information to do this is available, often in the organization’s systems. In addition, the technology exists to enable even fysical purchases to be a lot less painfull. What organisations need, and currently lack, is a good, quantified understanding of the cost of the transaction to their users.

Get rid of irrelevant process steps

For those of you who speak either Dutch or French, a nice journalist named Brigitte Doucet wrote a comprehensive article based on the keynote I gave at the Software AG Process Forum in February 2011. While I am formally no longer actively working in burden reduction, one of the key elements in our internal audit approach at the Belgian Development Agency will be to reduce both the administrative burden to beneficiaries and the internal cost of managing that to the optimum point. While written for for-profit environments, some of the ideas and lessons apply to non-profit as well. Enjoy the read!

You can find the Dutch article here, and the French article here.

Public sector performance enhancement

Let’s not get run over again

There are quite a few performance enhancing methodologies for administrations available on the market today. Most have not proven to be that successful all the time. However, under pressure to enhance performance, the public servants hope if or rather when someone turns government around, they don’t get run over again.

Potential added value of performance related methodologies

Can we integrate some of these approaches and methodologies into a comprehensive, sensible whole? There are four methodologies that can be integrated into one relevant, value added approach that has a real potential for adding value. The integration may prove relevant for administrations because most of the analyses executed in the past years can be used to feed this integrated approach. The investment in analysis and development of the past years will not necessarily go to waste. This reduces stress on the public servants that are trying to do their job.

Combining four existing methodologies in one new approach

How do we go about developing the best possible solution for the execution of a given role or responsibility? We aim to hit the optimal total cost to society for a public service or good. Which methodologies and/or tools would I use in what order?

1. Extended burden measurement - I suggest starting with an extended burden measurement in order to determine the actual total administrative burden to on the one hand the citizen and/or organization impacted by this responsibility and on the other hand the government charged with preparing the legislation, implementing it and ensuring compliance. Based on this initial calculation, we need to determine which activities or requirements can be cut at what level, where cutting is the most optimal. Important: I am not starting from the assumption that we need to cut burden to the citizen or the organization first. We need to cut where the effect of cutting is the most relevant, i.e. reduces the total cost the most. The burden to the citizen or the organization, as defined by the Standard Cost Model, is a function of the time invested in complying with the requirements and the out of pocket costs which are part of the compliance. These are very direct costs, as these are cash-outs directly related to the role of the administration, which is bothering you until you comply. The costs to government, while less direct in nature, are still cash-outs, as these are being paid for by our taxes. These costs to government are the subject of our second methodology.

2. Cost optimization at the level of the administration - When an administration is tasked to execute a role, it needs three elements: it needs people to execute, processes which these people need to follow, and technology to support these people and where possible replace them in repetitive work. This costing exercise exists under many names, but has been executed one time or another in the past years in most administrations. The data gathered here can easily be used to determine the cost elements internal to the administrations in calculating the extended burden. The risk of unchecked administration bloat needs to be countered using ideas on lean administrations.

3. Lean administrations governed by management contracts avoid administrative bloat: once beyond a certain size, traditional organizations in both public and private sector no longer exist to fulfill a purpose, but primarily exist to maintain themselves. Using management contracts limited in time which define SMART outcomes the relevance of which is questioned on a regular basis, and which can be achieved with the right resources while maintaining a positive cost/benefit balance, managed by risk metrics has been the subject of a previous post.

4. Risk metrics based on well-defined and researched risk management systems which are tasked with monitoring the weaknesses of and threats to the achievement of objectives by an administration are an essential tool to make sure that the effort of the administration, in terms of both budgetary means and resources, remains focused where it needs to be.

An approach well beyond window dressing

By integrating four of the most current public management methodologies, i.e. burden measurement, cost optimization, lean administration/lean government and risk management, we can develop an approach which makes sense to the public servants and finally gives them a shot ata structural improvement of their activities, which goes beyond current window dressing with maturity assessments which only identify a problem based on interviews and are not made for or capable of providing a comprehensive and pragmatic solution. Making the performance optimization effort transparent will significantly increase the credibility of the public sector as a whole.

The impact of simplification on residual risk

Red tape increases risks

Red tape is likely to lead to increases in residual risk profiles of organizations. These organizations are overburdening their external and internal customers with these increases in rules and regulations they need to comply with. Contrary to their expectations, this will not lead to more care. The more rules exist, the more this will lead to less care. Less care will reduce the risk awareness of the customer facing employees because they too are jumping through the hoops. The reduction in risk awareness will result in a higher residual risk profile because the assumptions are not checked nor questioned and may turn out to be false.

Past relevance of red tape

Introducing red tape in organizations was initially done to ensure that operations ran smoothly. A lot of the operations in larger organizations in the industrial era were 'standardized' to reduce costs. This approach was copied in service organizations and public sector entities as well. This led to productivity increases, which were a good thing from a cost side. However, the more you standardize a process, the more difficult it will be to provide deviations to the standard product. As Ford (presumably) has said: "You can have any color of car, as long as it's black." The choice in the Model T was limited. You had the choice of black, black or black. In addition, people on the work floor were discouraged of showing initiative and thus did not take ownership of the process. This part was also mirrored in different organizations.

Assymetrical information availability influences risk

A risk profile of an organization is a view on the risks to which an organization is exposed. A risk profile is specific to a company but heavily influenced by the industry in which is operates as well as the overall business environment in which the organization lives. A lot of different elements can influence a risk profile. First, there are risks external to the company. These risks in the organizations environment will influence its risk profile. The organization can do little about these risks, which can include the business environment, demographical evolutions, weather, disasters such as the Deep Water Horizon ... but they will impact it, and may impact it severely. A risk profile also consists of operational risks. These risks occur in everyday operations of the organization. One of the possible risks which can influence or worsen other risks is the red tape. More on that later. Finally, we see decision making risks. Information out of the external and operational environment is reported to the decision making levels which are not necessarily intimately aware of the situation on the ground. They base themselves on decision information. Any errors in the assembly and presentation of this information can lead to faulty decisions. Therefore, these risks influence the risk profile as well. These risks in turn can be significantly influenced by the red tape risks.

What happens if you leave red tape unchecked?

Imagine a situation in which an organization continues to develop red tape procedures beyond the point of marginal returns, i.e. the point where the procedure stops making sense. Compliance, if reached at all, will be reached with minimal care as the users do not see the relevance or the benefit of the additional requirements. More rules lead to less care.

Now, imagine a situation in which an organization is run based on rules and only rules, with any remarks or dissenting opinion ignored or punished, because its deviant behavior. New hires will very quickly stop caring. This is exactly what is witnessed in this type or organization, often hierarchical organizations. Now, if your collaborators no longer care, they will not be aware of will not mention elements influencing risk profiles. In essence, their risk awareness will be significantly reduced.

And when the risk awareness in an organization reduces, the likelihood that risk exposures are identified, flagged, assessed and managed reduces. What happens is that the real residual risk profile of the organization will become higher. Now, every increase in risk has an associated cost, all other elements remaining equal. So, either the organization accepts the higher cost of the risk management, therefore losing the assumed benefits of red tape increases, or the organization will be exposed to more risk.

The simpler the process, the lesser the risk

Introducing simplification projects which aim to reduce red tape will likely bring terror to the corporate identity. They are not used to these exercises, and they are counter-intuitive to much of what they have learned. However, think about the following: you will introduce more care in the execution of the activities of your organization, which will be appreciated by your customers. The increase in care will lead to an increase in risk awareness, which should lead to a reduction in the residual risk profile of the organization.